Insurance regulation in America

American exceptionalism

The world's biggest insurance market is too splintered

KANSAS CITY, Missouri, is known more for its historical role as a cattle town than as a financial hub. But it is to this midwestern city, America's 26th largest, that regulators and insurance executives from around the globe head when they want to make sense of the world's largest—and one of its weirdest—insurance markets.

For it is in Kansas City that the National Association of Insurance Commissioners (NAIC) is housed. It oversees a market accounting for one-third of premiums written worldwide. Outside Kansas City, the market becomes a regulatory free-for-all. Each of America's 50 states, plus the District of Colombia, governs its insurance industry in its own way.

In an increasingly global insurance market, America's state-based system is coming under strong pressure to reform. Insurance has changed dramatically since the NAIC was set up in 1871, with growing sophistication in underwriting and risk management. Premiums in America have ballooned to $1.1 trillion and market power is increasingly concentrated in the hands of big players (some of them foreign-owned) that are pushing for an overhaul of the state-based system. “It's an extremely expensive and Byzantine process,” says Bob Hartwig, an economist with the Insurance Information Institute, a research group.

Though a fiercely political issue, congressional support for simplifying the system is gaining ground. Both houses of Congress are looking at proposals to change the state-based system. Big insurers favour a version that would implement an optional federal charter allowing them to bypass the state-by-state regulatory process if they choose. A similar system already exists for banks.

Proponents of the changes see more efficiency, an ability to roll out products more quickly nationally and, ultimately, better offerings for consumers as a result. Yet some consumer groups favour state-based regulation. They believe it keeps premiums lower than they otherwise would be. Premiums as a percentage of gross output are lower in America than in several other countries (see chart).

The political headwinds are strong: insurance commissioners are elected officials in some states (California, for instance) and appointed by the governor in others. The industry is also split: most of the country's 4,500 insurers are small, and many of them have close ties with state-based regulators, whose survival they support. But even these forces may eventually be overcome.

Elsewhere in the industry in America, there are other calls for reform. In a backdoor form of protectionism, American reinsurance firms have long benefited from a regulation that requires foreign reinsurers writing cross-border business into America to post more collateral than they do. “If you operate outside the borders of the US, they don't trust you one inch,” laments Julian James, head of international business at Lloyd's of London, which writes 38% of its business in America.

The collateral requirement was established because of worries about regulatory standards abroad, and the financial strength of global reinsurers. Today regulatory standards have been tightened in many foreign markets. A majority of America's reinsurance cover now comes from firms based abroad, including many that have set up offshore in Bermuda (for tax reasons) primarily to serve America.

Pesky foreigners

So after years of hesitation, serious discussions about reform are under way. As a result of last year's devastating hurricanes, reinsurance capacity is tight. That has helped drive up primary insurance rates in places like Florida, which suffered heavy damage from the storms. Whether because of this or not, an NAIC task force is now considering a proposal to adopt a fairer rating system that would judge foreign and domestic reinsurers on the same measures, such as financial strength and strength of regulatory oversight in their home markets, to set collateral. The prospect of more streamlined regulation and recent moves toward reform in America's tort system (class-action suits can cost insurers millions) may make the market more attractive for foreign insurers.

Even under the existing rules, the size of the market has attracted foreign investment. Swiss Re recently purchased General Electric's reinsurance arm, and Britain's Aviva is in the process of buying AmerUs, an annuity business, despite selling its property-casualty business in America just five years ago. Philip Scott, who runs Aviva's international operations, says the rate of growth in America made the deal, which has not yet received regulatory approval, compelling. If any or all of the reforms finally go through, it is a safe bet that more foreign firms will follow in Aviva's footsteps—though they may skip the trip to Kansas City.